Brett King and the Death of the Branch: Part 1

In Part One of this three-part series, King examines how Amazon, Apple and Kindle helped light the consumer fire for electronic commerce.

There’s a strong statistical argument to be made for disruptive technologies that change consumer behavior. I’ve argued the impact of this on branch banking extensively, starting with Branch Today, Gone Tomorrow and more recently in Chapter 3 of Bank 3.0, but I’m still faced with significant resistance in the retail banking industry at large. So I thought I’d share a statistical view of the triggers that result in the deconstruction of traditional distribution systems, and look at the evidence in the retail banking space.

Core Behavioral Shift

The argument at the core of anticipating widespread disruption to the physical distribution channel within retail banking is to examine changing behavior around the branch, and if there are any patterns we can learn from in other industries. In industries like music, books and video rental we see historically the same triggers and shifts, along with the same reluctance to accept the inevitable changes that this brings.

In each industry we’ve seen majors like Tower Records, Borders and Blockbuster (see Wikipedia’s List of Defunct Retailers of the United States to see the full effect of disruption in distribution) faced with the same core shift, and an inability or unwillingness to change their distribution model to match changing consumer behaviors. In the retail banking market, we’re seeing the same reluctance to believe that anything will be fundamentally different with passionate arguments that the “branch will survive.” So what is typically at the core of this imperative for change?

In each disrupted business or industry we see a paradigm shift in distribution initiated by a technological breakthrough that changes buying habits. These paradigm shifts are sometime convergent as in the case of the iPod and iTunes, but correlate with a core product model such as the shift from buying entire a, to just buying (or downloading) singles. In the case of books the core buying behavior is characterized as eBook versus hardcover or paperback, but the eBook wasn’t really a serious competitor in the buying behavior stakes until Amazon launched the Kindle eBook reader.

At the core is an emerging behavior that demonstrates a trade-off between buying convenience and the need to “touch and feel” the brand or product in-store. Often the new product also provides a substantial price benefit because of lower distribution costs, but not always. Great new product mechanisms show that convenience and ease of use will often even trump pricing disadvantages (such as in the case of a booking fee for cinema tickets).

In each instance of buying behavior shift we see early adopters first out of the gate on the new technologies that allow different buying or consumption. We then see both traditional consumers and retailers voice extreme skepticism around the import of this new emerging behavior, and finally we see rapid adoption of the technology over three to five years resulting in an irreversible upheaval of traditional distribution systems.

This cycle of adoption and industry realization might be likened to the Kübler-Ross model, commonly known as the “Five Stages of Grief”, the only difference being that by the time the industry at large accepts the core consumer behavior shift, a few major brand names have already gone the way of the dodo bird.

Those That Have Gone Before Us

The cycle of disruption can be articulated in the following simple manner. We start with physical products in a physical store supporting the traditional distribution structure. A new distribution platform (such as the Internet) comes along and changes early adopter buying behavior – we still buy a physical product but it comes through a digital store. Finally, the product (where possible), is abstracted to a digital form (digital product) which is digitally distributedwithout the need for the traditional stores.

To support this process we need both changing consumer behavior and the paradigm shift of an emergent digital product. While Amazon has disrupted book sales massively through the Kindle, it can’t affect the same rapid level of disruption on clothes, shoes and electronic goods because those products can’t be fully digitized. When you digitize the product, it eliminates the majority of physical stores required for distribution over time because consumer behavior shifts away from visiting the physical store as the primary buying behavior. Whereas, when a physical product is retained, there is more of a split along buying preferences (e.g., in-store versus digital store) and the same shift takes longer or levels out.

Part 1 Continues ...

The other interesting side effect of the disruption cycle is that in industries where the physical distribution layer is destroyed, incumbents rarely survive as the dominant distribution players. Look at books where the likes of Borders and Angus & Robertson failed in the past two years, Barnes & Noble still struggles to survive and Amazon absolutely dominates hardcover, paperback and eBook sales across the United States (and to some extent globally). Amazon is now the largest distribution player in book sales bar none – because it owned the new emerging distribution platform; i.e., the digital book and reader combined with the digital bookstore.

In the graph below we see the Kindle emerged to support the eBook platform in the late 2007 period and that by 2010 the effect on buying behavior is acute, with physical sales of MMPB (Mass Market Paperback Books) quickly undermined by eBook sales.

Between 2010-2012 the effect starts to have a multiplier impact on the speed of decline as the majority of customers change their buying behavior. This behavior does plateau at a certain point, but the primary distribution channel for book sales has already shifted and will never return. Amazon still gets some appreciation in physical book sales for a time, primarily due to the fact that other physical stores are failing at the same time. Even if physical sales of books continues to appreciate based purely in line with population growth or total market size, the damage to the long-term viability of physical distribution channels has already been done.

Physical books versus eBooks sold on Amazon.com (source: Amazon)

The same occurred in music. If I told you in 1990 that the largest seller of music in the United States in 2010 would be Apple Computers (or Apple Inc.) you’d likely have thought I needed help from a mental health professional. However, due to the paradigm shift in music sales Apple dominates while Tower Records, Virgin Megastores and others have dwindled into virtual obsolescence due to changing music buying habits.

Retail stores accounted for 36% of total album sales [in 2012]. This figure was 66% just seven years ago…” TheStar.com, Jan. 17, 2013 (citing Nielsen SoundScan)

Timeline of Digital Music Sales Growth in the US (2004-12); Source: Nielsen

Sometimes this is not only evidenced by changes in buying behavior in stores, but also by a change in the modality of the product. One of the big changes around the iTunes/iPod platform was a shift from buying albums to buying singles, something that was counterintuitive for the music industry under the old, store-based distribution model.

The “99-cent single” model that Apple pioneered with iTunes helped incent customers to the new buying platform away from physical products in physical stores. The paradigm shift in music was still iTunes and the iPod, but the new format allowed much less friction in buying and raised unit sales significantly. Sometimes this was just about the pricing and convenience, but it was assisted by the fact that I no longer had to buy a whole album just to get one single.

The cost of distribution of physical CD albums was impractical to apply to singles because margins on the product were much thinner and wouldn’t work. So even with better stores or more intense marketing, the physical distribution layer could no longer efficiently compete against the new distribution platform. The destruction of physical music stores as the primary sales channel was complete (queue menacing laugh “Bwah ha ha ha.”) If you doubt this assertion, just go back and review the quote from TheStar.com above.

The same happened in the video rental space and with the shift from 35mm to digital cameras. By no longer requiring a physical store to buy film or process photographs, the traditional distribution layer was destroyed. The modality of photography also changed as smartphone cameras became more capable, with higher resolutions and then combined with apps like Instagram, Foursquare check-in and such which changed our behavior around photography and videography.